Column: What Was the Question?

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It is nice to believe that the world is simple and that we can easily get high-quality answers to our questions. But in fact our reality is mostly very complex, and we don’t understand it well. The bottom line is that we need to spend more time helping people understand and deal with complexity and less time concocting dumbing-down mechanisms.

A perfect example of what happens when you dumb down complexity occurs in the personal finance industry. When we face something as complex as money, we have an urge to simplify the problem. But we often oversimplify it, by creating add-water-and-stir solutions.

When we face something as complex as money, we oftenoversimplify it by creating add-water-and-stir solutions.

Typically, a financial adviser takes 1% of assets under management—annually!—to balance a portfolio, and makes investment decisions on the basis of our answers to two questions: (1) “How much of your current salary will you need in retirement?” (2) “What is your risk tolerance on, say, a 10-point scale?”

Frankly, I think highly trained monkeys could do the same basic job given answers to those two questions. Certainly algorithms can do it, probably with many fewer errors. This is just not something for which we should pay 1% of assets under management. But the real reason we should not pay for it is that those questions don’t help optimize our portfolios.

To prove this, I asked many people those two questions. The most common answer to the first one was 75%. After some probing, I learned that most people named that amount because they’d heard it as a rule of thumb from financial advisers and from the media. You can see the inane circularity: Financial advisers are asking customers a question that the customers are answering with what the advisers have told them is the right response.

When I changed the question to “How do you want to live in retirement?” and costed out where people wanted to live, what they wanted to do, and so forth, I discovered that they would actually need almost twice as much: about 135%. (Think about how much money you would need if you had nine extra hours a day in which to spend it.)

I also asked people the risk question, varying the labels on the ends of the scale. I told some that the low end was 100% in cash and the high end was 85% in stocks and 15% in bonds. I told others that the low end was 100% in bonds and the high end was 100% in derivatives. Regardless of the labels, people chose somewhere near 5, depending on whether they felt slightly more or slightly less willing to take risk than what they thought of as average.

So what do we have? A service that costs 1% a year and is based on two not very useful questions.

Maybe it’s time for less monkeying around. Financial services—and business in general—needs to embrace the complexity and difficulty inherent in our lives. It’s easy to see why this is not very likely to happen: It’s harder than add-water-and-stir solutions, which offer instant gratification and the illusion of progress. But unless we admit how complex the world is and how little we really know, we will not search for better questions, better ways to comprehend the world, and better answers. A deep understanding of what we’re trying to accomplish will always yield better answers than a “red is bad, green is good” approach, even if it doesn’t feel that way.

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